The Supply Chain for Milk – rain, grass, cows and a lack of flexibility

The world outside our bubble doesn’t take a lot of interest in procurement and supply chain issues for most of the time. But in the UK at the moment, we have two issues on the front pages! As well as management of the Olympic Security contract, now the price of milk and the complex supply chain for that product are featuring in the headlines.

More accurately, the issue is the price that farmers can get for the milk they sell from their dairy farms, and whether it is enough to provide them a sustainable living. Much of their production goes to the big dairy processors, who convert a high proportion of it into cheese, butter, cream, yoghurt and other products, as well as selling it in liquid form to retailers and the old fashioned door to door “milkman”. The processors, dominated by Dairy Crest (a UK publically quoted firm), Robert Wiseman (now owned by the giant German Muller foods group ) and Arla Foods (a Danish / Swedish co-operative) have reduced the price they pay to the farmers on the back of failing returns for their products, particularly cream.

Some farmers sell directly to various buyers, largely retailers, dominated by the large supermarket chains, Sainsbury, Tesco, Asda and so on. Interestingly, in this case, it isn’t the big boys who are being most criticised by the farmers – Tesco, Sainsbury (and Waitrose) pay a decent price. The discounters, Asda, Morrisons and, strangely, the Co-Op (who trade on their image as a public spirited organisation) were named initially as villains who wouldn’t pay a reasonable price to farmers.

The key to the milk supply chain

That caused a pretty quick response from the Co-op, who clearly can’t afford their entire market positioning as good guys to be soured by this. Morrisons quickly followed, announcing they would up their payments. Others paying low prices to the farmers include large catering firms, food manufacturers – and perhaps even public sector buyers?

And the processors are also being painted as major villains, with farmers blockading processing plants. But if you look at Dairy Crest’s returns and financial results over the last few years, they can hardly be accused of profiteering. Equally, if I’m a dairy buyer (and that’s how I started my procurement career with Mars, many years ago), your job is to get the best value for your organisation. It would have been tough explaining to my boss that I was going to pay a few percent more than I had to in order to “save the UK Dairy industry”. It would have been my job that needed saving, I suspect..

Indeed, doing a Professor Andrew Cox “power in the supply chain” analysis would be interesting for the dairy industry. It’s not clear that the processors are really that powerful, although it must look like it to the farmers. But a key problem in markets like this is the unresponsiveness of supply to demand. You can’t just turn off a cow; a farmer can’t go onto part-time working. So relatively small changes in demand don’t get the response you might expect in most other markets from the supply side. Producers are also apparently locked into 12 month supply contracts with the processors, which seems odd - does that mean they're committed even if processors reduce the price? An unusual sort of contract...

But if supply is relatively fixed, at least in the short to medium term, then classically price has to drop in order to increase demand and get the economics back into synch. But that takes us into a level of financial returns where UK farmers cannot produce milk profitably (they say). That’s partly because UK conditions are not ideal for dairy farming. They’re not bad, but other countries like Ireland and New Zealand have lower costs and are therefore better positioned on the world markets – cheaper land, more rain, more natural grass for the cows (which avoids the cost of expensive feed).

So what happens next? Arguably, the pure market solution would be for the UK to produce less milk and allow economic activity to switch into something else. But do we really want to lose our domestic milk supply base, with potential supply continuity issues at some stage in the future? And do we want to see small dairy farms disappearing from the countryside? I suspect the farmers have done enough (and respect to their excellent PR campaign) to get a response from the retailers that might just about address their complaints in the short term. But the pressures from world supply markets are likely to continue.

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